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Endgame of Bitcoin and Cryptocurrencies: A Scenario Analysis. Will crypto be a good long-term investment? Should I hold my crypto/Bitcoin for long-term gains?
Summary:
The present period resembles the dotcom bubble (discussed in detail).
Multiple parallels exist between the present period and the dotcom bubble (discussed in detail).
Game-theoretical analysis reveals that Bitcoin/crypto, in the long-run, is very likely to be banned (discussed in detail).
Multiple methods can be used by governments to ban crypto/Bitcoin (discussed in detail).
Keywords:
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History repeats itself, said Karl Marx. . . yet it is important to know that while history does 'repeat itself,' it does so in different ways. This is a reality that has manifested in business cycles. It is a principle whose understanding can benefit a rational mind.
Bitcoin and crypto, presently, are what everyone and their dog are interested in or invested in. A vast amount of the transactions on the online crypto exchanges are from smaller retail traders, with the common assumption being floated that the future is crypto, and the most prominent player is Bitcoin. It is said to be the worldwide web 2.0, with proponents at times acting as evangelists to praise its glory.
Its role and prominence seem to further establish every day it stays at an elevated price level, with proponents pointing their fingers at the exorbitant price, stating that no bubble can last this long. Yet, is this accurate, rationally?
What are the future scenarios traders or investors in cryptocurrencies should be aware of? What is the likely endgame for the present cryptocurrencies? What is expected to happen in the future with cryptocurrencies? These questions are addressed in this report.
So, what period of history closely resembles the current condition of cryptocurrencies and their birth?
If you look at the world or US economy, a different argument can be made, supporting the hypothesis that we are, perhaps, in an era similar to the '40s; or, alternatively, the economy is likely to enter a period such as the '80s. However, when you look closely at the condition of the economy and cryptocurrencies, the late '90s and early 2000s stand out as the best contenders:
A new technology emerged; the technology was made accessible to the masses, multiple entrepreneurs jumped in to profit from the new technology, and money was thrown without fundamental investment assumptions or principles being met, all in the name of revolutionary technology . . . if that does not resemble the late '90s or early 2000s to you, then perhaps you didn't experience that era, or haven't thoroughly studied it . . .
The 2000s bubble and crash (Summary)
In the early '90s, only about 2% of the US population used the internet due to operational complexities involved with usage. Then came 'Mosaic,' essentially, a web browser that eliminated some degree of complexity associated with using the internet and accessing information online. Web traffic exponentially increased with the invention of Mosaic, with a 1000% increase within the month of its release.
Concomitantly, during this period, the FED in the US dropped the discount rate (to tackle the downturn of the yearly '90s) from 7% in November to 3% in August 1992. A 60% decline approximately. Capital became cheaper, and with an assumed revolutionary tech, entrepreneurs started launching all sorts of 'dotcoms,' with primary business viability and logic lacking, more and more, behind these launches. Arguably, the illogical behavior of agents started to shift more towards the frenzied irrational state from 1995 onwards.
In 1995, with the launch of the Netscape Navigator browser, which was known for a faster and easier interface. While Netscape was not making any profits, its IPO was launched, and on the first trading day, the stock increased about 100% . . . in 1 day.
There was an exponential increase in internet users and websites from 1994 onwards. It seemed that a new era had ushered in . . . with a 'to the moon' mentality prevalent in the market. Financial stress-related indices started moving up from 1997 onwards, yet the market didn't show much concern.
While there was some growth in profits of online companies, the investment in these ventures was disproportional, i.e., their profits, if any, were not growing at a pace comparable to the inflow of investments in these ventures. Financial delusionalism was also prevalent during this time.
Investors, governed primarily by greed, were further misguided by 'professionals' who saw short-term losses of internet companies likely to be over-turned—the classic discounting of a future positive NPV. Suffice to say that the capital inflows in the dotcoms weren't managed efficiently or rationally by the 'management' of the dotcom businesses.
By 1999, Nasdaq increased approximately 290%, from its 1994 value, a yearly increase of about 27%. During this time, sales growth was becoming, more and more, the parameter of choice for investors, the assumption being that with increased sales, over time, profits would also start to materialize. This led to many companies selling below cost, overspending on marketing, and moving towards M&As for increasing their sales; the fundamentals of organic growth were abandoned to increase sales volumes.
In this environment came the fear of the Y2K bug. This scare led to wide-scale computer updates, which further increased the sales of tech companies. Stocks started seeing their returns increase by many folds for some. This further added fuel to the fire, arguably, pushing markets into a state of crazed mania.
This condition, similar to the 1930s, led many people with no financial training to move into trading stocks. On March 10, 2000, the Nasdaq reached 5000+ points; this, in terms of reflection of fundamentals, meant a price 200 times earnings. However, the FED by June 2000 had increased the discount rate to 6%, arguably, due to concerns of overheating.
Global economic conditions around the end of the '90s were taking a turn too. With the FED moving more towards, let's say, conservative policy (contractionary policy), selling pressure on stocks during this time, the late '90s to early 2000, was gradually building up. In March of 2000, when it was announced that Japan had entered a recession, Nasdaq suffered its 4th largest loss (compared to periods before 2020). This caused investors to turn skeptical and fearful – questioning their investments' long-term survivability and capital requirements.
With investment inflows drying up, the new dotcom and technology companies started burning through cash. As investors' profit expectations did not materialize, the selling pressures of stocks increased from moderate to severe. In a very short amount of time, companies worth exorbitant amounts of money became worthless. Managements' mismanagement and imprudent agency were uncovered. In some instances, fraud was also uncovered. All these reasons, in amalgamation, worked as a contractionary tsunami, to undo the economic and market gains of the mid to late '90s.
The US entered a recession in March 2000, and the bottom of the market (Nasdaq) was reached in October 2002, at about 1100 points, approximately 80% fall, 'peak to troughs.'
The economic implications were severe; almost half a million tech workers lost their jobs during this period. Of course, whenever there is such a severe impact on employment levels in an economy, there are ripple effects; consumption, investment, savings, all major economic parameters are impacted with such a move in the job market, and so they were.
Thousands of names that were thought to be the future and had money thrown on them, from left, right, and center, went extinct. The recovery was slow, with the annual US real GDP, till 2020, never hitting the 1999 growth rate of 4.75%. Many promising names vanished in a short amount of time.
The most important lesson, however, is that those that lost fortunes, thought that the investments they were pouring their life savings in, were the future. If you could go back in time and present arguments that we know now are correct, you would be considered a naysayer, a pessimist. This is because they thought, as always, that "this time it's different."
"Oh, how we always forget. . ."
The parallels are fairly obvious for those willing to see. This present era very much does resemble the dotcom bubble:
1. As in the dotcom bubble, an emerging tech (Bitcoin and blockchain) has gone mainstream, the impact is similar to that of the emergence and prominence of the internet, especially enabled by Mosaic in 1993.
2. The Fed cut its discount rate by 91.6%, from 3% to 0.25%, to tackle the economic downturn caused by the covid crisis. This is similar to the 60% decline in the FED discount rate in the early '90s.
3. In the last few years, thousands of new ventures, which we are made to believe are 'currencies,' have been launched, just as the massive boom in the dotcoms in the '90s. Even though these 'currencies' do not possess the fundamental economic attributes required to be considered a currency.
Yet, similar to the '90s, people aren't asking highly skeptical questions, with the assumption being fed, or consumed, that this is the future. We are on the bandwagon, just as we were in the '90s. Greed as an impulse, it seems, can supersede the instincts of rationality.
4. Just as the irrational state of the markets further moved into a form of manic frenzied state after 1995, arguably, we have seen persistent episodes of manic behavior in the current state of the markets, of both equities and 'cryptocurrencies,' with ventures that started as a joke, being worth more than $35 Billion, and certain shares, such as Tesla (TSLA) trading at prices which equate to a P/E ratio close to 1200 (April 2021). The irrationality of the markets is at full display presently.
The arguments, ironically, are very much the same, as they were in the '90s: Profits or returns may not be present for certain 'opportunities' in the market, currently, oh, but these ventures are the future after all, and the profits will arise in the future. "Just as they did for pets.com, flooz.com, or boo.com, right? Oh, how we forget . . ."
5. With the invention of cryptocurrencies, its often argued that a new era has ushered in . . . as we were supposed to believe in the '90s with the dotcoms. While it may be argued that a new technological advance has been made with the invention of the blockchain technology, etcetera, it is also important to note that multiple revolutionary technologies have been invented or improved in the last decade, for example, neural networks or advances in fintech, yet we are made to believe that this one invention, the blockchain, trumps all other. . . thus, money should be thrown at it in a manic frenzy? Coming back to the dotcom bubble, as we now know that while some ventures did succeed long-term, the overwhelming majority failed.
The money thrown at these ventures was unjustified, as is the case with the current condition with many 'opportunities' out there, valued as if the world is reliant on them. Those that question the viability of these 'cryptocurrencies or hyper valued companies, for example, usually, are given a generic concoction as a reply": oh, you don't understand what blockchain is," or, "You can't comprehend what this is going to do in the future." A first-year college student can impose this argument over a distinguished professor of computer science, yet, arguably, the majority would support the freshman.
The assertion imposing cryptocurrencies as the future, discounts all other emergent technologies, as if crypto is the only technological advancement that is leapfrogging everything else. Usually, there is also a dismissive attitude prevalent in the proponents, which is comparable to the condition in the '90s, just as proponents of the new dotcom companies were very dismissive of the skepticism or of questioning regarding the new companies and their long-term viability.
6. Due to excessive increases in the stock market in the mid to late '90s, many people left their day jobs to trade stocks. With the Nasdaq composite index increasing at a growth rate of 27% (geometric mean) YoY, making money, even without a fundamental understanding of finance or economics, was possible.
Similarly, presently, we have seen a substantial increase in retail accounts and trading by individuals without the required prerequisite skills to trade securities, even though the stats on these accounts are out there. An overwhelming majority of retail trading accounts lose money, yet we have seen a substantial increase in these accounts.
The parallels are undeniable for those who are willing to see them. However, the abandonment of logical reasoning is a symptom of mania, and to those willing to see, the condition is quite obvious. These similarities, if they were written in a work of fiction, would surely have led the readers to question the verisimilitude of the work; yet, as events unfold in real life, they are largely ignored. The mentality is the same as before all economic calamities: "this is not that," and "this time it's different."
Another important issue worth understanding is that people, often misguided by fake clairvoyants or false Messiahs, start to take a form of devout conviction towards their views . . . even though they cannot know the future of their highly speculative bets, they believe that it's going to be as they envision it . . . this can be classified as a form of faith. . . which history tells us, always leads to ruin. How many times have we heard: 'Bitcoin is the future, man, I just know it, haven't you heard the pros talk about it?"
Future scenario analysis. What will happen with Bitcoin and cryptocurrencies in the future (end game analysis):
With the parallels with the 2000 period established, we can move forward with the assessment of future possibilities. First of all, looking back at history, we should understand and accept the fact that people, that is the majority, has been wrong, again and again. History is littered with examples. Thus, we should take all 'established axioms' with a grain of salt. For example, people argue that Bitcoin cannot be banned . . . the agenda is to establish this condition as a fact. This argument and others are discussed in this report.
In future analysis, we need to understand the most likely, most probable, scenarios. Bitcoin's market cap increased from $17.49 billion, in the first quarter of 2017, to more than a trillion dollars in 2021, a 66.4x increase. Blockchain wallet users in the same period increased by about 5x times. What can be deduced from this?
Bitcoin's value, and, arguably, its usage, has been increasing exponentially, and if it continues at this rate, soon it will become an annoyance for the governments, as it encroaches on their monetary authority/power.
We haven't seen any significant move made by any country belonging to the OECD yet, but is it likely to change? Also, can it change? Can the governments stop Bitcoin now? If yes, then why would they? How can they?
There are two most likely scenarios that we must consider:
1. A Bitcoin-related negative event occurs that acts as a 'last straw' for multiple governments.
2. No Bitcoin-related major adverse event occurs, and Bitcoin gradually continues to increase in terms of market value and usage.
Scenario 1
As Bitcoin continues to increase in market value, its position would become more significant in the world markets over time. However, its growth may cause its demise. Bitcoin's price has very high variance, thus a very high risk associated with holding it. With a monthly sample standard deviation of returns for the last decade standing at an enormous 53% (variance = 28.1), which is more than 10x of the sample standard deviation of gold for the same period (data attached below).
Value at risk analysis reveals that Bitcoin, per month, has a 10% probability of losing 70% of its value, compared to a very modest 6% for gold (see data attached below). As Bitcoin increases in value, and if its variance remains the same, it creates a very significant and very severe risk for the stability of the global financial system. This is a strategic risk; central banks and their regiments of PhDs continually scan for strategic risks, and this risk is very likely to be on their radar.
A $5 trillion decline, approximately, in the value of the S&P 500, in conjunction with other elements, created a severe financial crisis in 2008. When Bitcoin's value increases above the $3.5 billion mark, it will become a significant risk to the global financial markets, and that is when central banks and governments around the world would start to get more serious about it, as their risk models "beep madly in red." They are very likely to act, as it would raise the financial risk level to a metaphoric economic "DEFCON 2 to 1."
Alternatively, it is possible that the action to curtail, or the will to do so, initially, is weak, and Bitcoin continues to rise. In that case, it is plausible that Bitcoin continues to rise to a value that does present an instability risk, for example, its market cap does increase over $3.5 trillion.
In this scenario, it is very likely that a severe downside move, which we know through the variance analysis is very likely, results in severe losses in the crypto market as a whole; for example, Bitcoin drops from $150,000 in value to $10,000 in value. We know through the VaR analysis that this can happen in 1 quarter or less. Such a move would destabilize the global financial system at a level comparable to the 2008 financial crisis; action by the authorities wouldn't just be needed, it would be imperative. The scenario would present a situation that is an amalgamation of the worst attributes of the dotcom bubble and the 2008 financial crisis.
How the authorities will act is discussed later, but actions for preventing such a catastrophe from happening again would be an absolute necessity. The actions taken by the governments would, arguably, be a form of Dodd-Frank act on steroids, specifically, for speculative assets with no underlying value. The practical implication of such an action would be the banning, or curtailment, of speculative assets without an underlying absolute value. How the governments may achieve this objective is discussed later.
Scenario 2
Let's assume that Bitcoin, through the inflow of institutional money, for example, stabilizes, and its variance reduces significantly. Risk concerns are dissolved over time, and Bitcoin continues to grow in value, gradually yet steadily.
What is likely to happen then? Will Bitcoin take over the monetary systems as a decentralized global currency, as its present gains suggest?
Bitcoin game-theoretical analysis (game theory analysis of Bitcoin's future)
Well, the exploration for answers in this scenario leads us to the utilization of game theory. The type of game is likely to be a static game, i.e., it is likely to be played once. The players, of course, would be the governments and central banks, with their powers combined, and thus represented as one, and Bitcoin, as the proxy for the Bitcoin investors. The game is likely to be a normal-from game.
"Normal-form is a representation of a static game with complete information specifying the players, their possible strategies, and their payoffs for each combination of strategies (Perloff, 2015)."
The outcome of the central bank-Bitcoin game can be best predicted through the best response for the two players. Each player is likely to adopt a dominant strategy.
"Best response is the strategy that maximizes a player's payoff given its beliefs about its rivals' strategies (Perloff, 2015)."
"Dominant strategy is a strategy that produces a higher payoff than any other strategy the player can use for every possible combination of its rivals' strategies (Perloff, 2015)."
A game's outcome can be predicted with a high degree of precision by understanding the dominant strategy for each player.
"A dominant strategy is a strategy that is the best response to all possible strategies that a rival might use. Thus, a dominant strategy is the best response. . . The idea that players use the best responses is the basis for the Nash equilibrium, a solution concept for games formally introduced by John Nash (1951). A set of strategies is a Nash equilibrium if, when all other players use these strategies, no player can obtain a higher payoff by choosing a different strategy (Perloff, 2015)."
The actors in the game, i.e., the central banks and the Bitcoin investors, both have agendas. 1. The central banks want to maintain, or potentially, increase their control or power, over the monetary system to better manage economic contractions and overheating. On the other hand, 2. The Bitcoin investors want to increase their profits and want a more decentralized system, in which they, as holders of Bitcoin, command more power. Thus, a diagrammatical representation in terms of game theory is presented below:
What does this diagrammatic representation tell us, in terms of game theory? We must understand the actions and their outcomes. In the first, upper left quadrant, we have a scenario where investment in Bitcoin continues to increase, and central banks do not act adversely against Bitcoin. In this case, the power of the Bitcoin investors, or, put another way, 'participants in Bitcoin,' would gain a higher power. On the other hand, the power of central banks would reduce.
In the second upper quadrant, the upper right quadrant, no player moves further from the current condition, and no change occurs; suffice to say that this is the least likely situation, both in terms of practicality and game-theoretical analysis.
The lower left quadrant represents a situation in which the central banks, to maintain absolute power over the global monetary system, block Bitcoin, and in response, all investment in Bitcoin dries out, i.e., investors stop investing in Bitcoin. Of course, this is not likely, strategically. Bitcoin, to the Bitcoin zealots, is a phenomenon, and even with a ban, it is likely that a limited level of underground activity would persist.
Lastly, the lower right, marked quadrant, represents the Nash equilibrium, i.e., the dominant strategy of both players in the game. After a certain level, central banks are likely to develop concerns regarding cryptocurrencies, not just Bitcoin, undermining their power. This is likely to be perceived as a strategic risk. Even if the circulation of cryptocurrencies reaches 5% of transactional exchange globally, central banks are likely to view this move as a significant deterioration of their authority.
This is likely to be seen as a severe strategic risk, as central banks are likely to see the rise of crypto, as a medium of exchange, as a phenomenon that reduces their monetary power in an economic contraction or economic overheating.
Thus, the best response for the central banks, over time, is to block the private crypto phenomenon. The arguments would most likely revolve around concerns regarding strategic risks, the risk of inability to maneuver the economy in a contraction or overheating situation, and concerns of adverse actors manipulating crypto to destabilize economic conditions in other countries for their own unscrupulous goals (designed speculative attacks).
The lower left quadrant is the condition most likely to occur in terms of practicality, and game theory also identifies this condition as the most likely.
Can governments ban crypto/Bitcoin? How can governments ban or block cryptocurrencies/Bitcoin? Everyone says they can't!
Proponents, primarily, present an argument based on the decentralized nature of Bitcoin and crypto. The assertion being that Bitcoin cannot be banned, as it is global in nature, its peer to peer, and involving a third party which might be regulated by a government or central bank is not required. Thus, deductively, it is claimed that Bitcoin can't be banned.
'Bitcoin, its circulation and its value, for all practical purposes, can be banned.
"So, are the proponents wrong?" Well, while their arguments may primarily be valid, the outcome they deduce from their valid arguments is unlikely. Put simply, for all practical purposes, central banks and governments can stumble Bitcoin and its market over time.
There will always remain a 'pocket of resistance,' if you will; however, for all practical purposes, Bitcoin and private crypto can be disrupted through government intervention.
How can Bitcoin be banned or disrupted by governments or central banks?
Governments and central banks, to preserve their monetary authority and maintain their influence over the economy, can ban or disrupt Bitcoin, for all practical purposes, with a three horizons approach:
Anyone of the discussed scenarios may materialize, yet the outcome is likely to be adverse for Bitcoin. The above described 3 horizons approach, or a set of strategies based on the measures discussed above, are likely to be implemented by international governments.
The first most obvious measure, horizon 1, of course, is most likely going to be an initial appearance of pressure against Bitcoin, which leads to an official statement being made for an outright ban against Bitcoin/crypto. The causes for such a move are not repeated in this section; only the logical chain of events likely to occur against Bitcoin/crypto are elaborated.
Horizon 2 would be a broader attack on all methods of conversion that permit users to convert cryptocurrencies into cash, for example.
All methods that enable cryptocurrencies to be exchanged for any elements of actual value would be banned. Recently, we have observed that Bitcoin's price in USD reacts bullishly to corporate acceptance. For example, whenever Bitcoin is accepted by a prominent firm as a medium of exchange of value, or as an asset, its price shoots upwards.
A similar reciprocal impact should be expected when Bitcoin is prohibited by law to be accepted as a medium of exchange. It is logical to expect the price to crash severely, in a short amount of time as this happens. Secondly, in horizon 2, the most impactful move is likely to be the ban of crypto-exchanges that enable users to exchange Bitcoins for fiat currencies, and vice versa, or for other cryptocurrencies.
Governments are likely to attack all methods through which Bitcoin or cryptocurrencies can be exchanged for cash, specifically, the ability for the cash, in exchange for crypto, to be transferred to any reputable bank (adhering to the Basel banking standards). This move, effectively, is likely to discourage and deviate all major investors or any institutions that may be invested in Bitcoin.
If you have a, let's say, highly encrypted code on your phone, which is highly protected through blockchain tech and, hence, valued highly by some, yet there is no legal or mainstream method to exchange it . . . what do you think this digital element would be worth? Admittedly, Bitcoin zealots may still value it highly, however, for every transaction to be matched with an equal and offsetting trade, would be very difficult to achieve, not to mention dangerous, in the time of the internet, when clandestine global trading can result in irrecoverable losses.
Thus, without international exchanges providing the ability to convert Bitcoin into legal tender, the majority of Bitcoin's value in USD would be lost, as larger investors scramble to recover their investment before it becomes irrecoverable.
There will, nonetheless, always be zealots that hold Bitcoin, or imagine its return. Theirs' is, and shall always be, a faith-based commitment, not a strict, capitalist estimation, of the value of Bitcoin.
Prominent central banks, in Horizon 3, to put the final nail in the coffin of private crypto and Bitcoin, would launch their own cryptocurrencies; thus, eliminating the need, as perceived by some but not all, to hold crypto for the convenience of the users. Central banks may also modify the mechanisms through which they determine the broader money supply; for example, including a rules-based peg with the quarterly productivity (GDP) that utilizes blockchain, to predetermines the money supply, based on the economic conditions. This, or a similar method, can eradicate the concern of infinite money printing, a primary concern that leads many to assume there is value in the scarcity of crypto, in relation to other fiat currencies.
Altogether, these measures combined should take the air out of the crypto balloon. When Bitcoin and crypto are declared illegal, no prominent companies can accept them as a currency, all the crypto exchanges are banned, with all methods to convert Bitcoin into money that can be transferred into a reputable bank account eliminated, and with central banks launching their own currencies, Bitcoin and crypto, for all practical purposes should be neutralized as a strategic risk.
There shall always remain a small band of zealots that continue to hold crypto; however, it would never reach the price levels that we see presently. Lastly, it may be argued that fiat currencies are worthless too. This assumption may not be accurate (see: Will the US Dollar Lose Its Value? ). In the long-term, currencies that are not based on tangible units of intrinsic value would only survive if the issuers of those currencies have the natural power to uphold them as legal tender.
This means power in the purest and crudest sense: the power to implement proclamations through force. And no, no amount of electricity consumption by any entity translates to any intrinsic value. All nonsensical arguments in the broader cryptocurrency debate, if you probe skeptically, are self-serving.
"Never ask a barber if you need a haircut . . . never ask those consumed by the mania whether we are in a mania."
Data:
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